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Price Analysis

Driving profitability improvement throughout an organization can be achieved in a variety of ways. Any number or combination of profit drivers can be leveraged to improve financial performance. However, all too often we see companies focused on just the margins themselves and not what’s driving them.

Consider the sales team that is measured or rewarded based on margin. Margin performance can fluctuate over time based on any number of changes to profit drivers including volume, pricing, product or customer mix, and costs. Sales teams have influence or control over some, but not all, of these profit drivers. So why hold them accountable or reward them based on overall margin performance?

Instead, hold sales accountable only for the profit drivers they can influence. Take, for example, a wholesale distributor sales team. They certainly have influence over sales volume. It’s part of their job description to positively affect volume. They typically have influence over pricing, too. Through targeted margin-based pricing, discounting and promotions, sales teams influence prices every day. And we know that pricing has very high leverage on profitability.

Consider too, product mix and customer mix. Sales teams have at least some influence over what gets sold and to whom. This is one profit driver that is not measured in many companies but often cited as a reason for declining margin performance.

Finally, costs can have tremendous impact on margins. But the sales team typically has little or no influence over costs. So why hold them accountable for overall margin performance when costs are such an integral component of it?

The way to positively impact your margin performance is to manage more deeply into the profit drivers that impact margin. Margin is a result or outcome of these drivers and not a lever in itself. Identify which profit drivers are within the control of your sales team, or any other function, and manage those drivers to get your desired margin result.

In the case of the wholesale distributor sales team, you will manage volume, price and mix to improve margins. This means monitoring their performance on each of these relevant drivers, and reporting and rewarding accordingly. Because cost is not part of this equation, using overall margin performance as the basis for evaluating sales performance is neither appropriate nor advisable.

We recognize that this line of thinking may be a leap based on how you measure sales performance today. But think about it: Sales teams rewarded on margin will close deals based on margin dollars and tend to ignore the other profit drivers available to them. When you manage these drivers and hold your sales representatives accountable for them, they will pivot toward the profit drivers they can influence and, in turn, improve margin performance.

For wholesale distributors and many manufacturers, price setting can be a daily occurrence. A multitude of products combined with a large number of customers makes for a complicated pricing environment.

You add to that complexity when you give your sales team the authority to adjust prices on the fly. Pricing becomes a highly dynamic activity, and the sheer volume of activity makes it difficult for you to determine whether aggregated price decisions are contributing positively or negatively to profit margins.

Access to transactional data eases the process of measuring price performance. And since most company information & ERP systems can deliver the necessary data to accurately measure price performance, why not tap into that information?

Fundamental data requirements include a baseline data period with item description, price, and units ordered. These are line-item numbers for each individual transaction taken from sales invoices. The baseline is compared to a current time period to measure the difference in price and quantity ordered, which represents the change in price performance when summed across the business. Positive price performance indicates a rise in aggregate pricing and a positive contribution to margins, while negative performance points to a decline and a negative impact on margins.

However, data alone doesn’t always provide actionable insights. When we look at price performance, it is more helpful to visualize performance across a variety of scenarios that will lead us to action and results. For example, analyzing by sales region or individual sales rep can provide insights into weak performers who may require redirection or support. Or, analyzing price performance versus cost changes will call out product prices that may be losing pace with rising costs.

We recently identified a product group being ignored by a wholesale distributor that had lost significant margin over time as costs had escalated while prices remained unchanged. The company was focused on higher-volume product groups and was unaware of the narrowing margin gap.

The data required to perform effective analyses can be extensive depending on the type of business. For example, wholesale distributors can have very large numbers of transactions resulting in large datasets. To process the thousands of SKUs and customers, we recommend a cloud-based price and revenue management analytics package that simplifies the measurement, monitoring and forecasting of pricing actions, allowing for midcourse corrections as market conditions change.

Having insight into price performance and its contribution to margin provides a clear path to actions for margin improvement. Having the ability to quickly drill down into specific areas of price performance accelerates the analyzing process and delivers results faster. Still, few companies are taking the initiative to measure price performance, and even fewer are drilling down to identify opportunities for margin lift. Don’t wait. Harness the power of analytical tools that enable you to turn data into intelligence. That intelligence can make all the difference in your quest to boost margins.

Nothing has more impact on profit margins than pricing actions. Yet, most companies don’t measure price performance and how it impacts margins. Price performance is the difference in prices across items sold multiplied by the number of units sold in a given time period. So, an item that increased in price by $1.00 and had sales of 1,000 units equates to $1,000 in positive price performance.

We typically think of this gain in price as falling straight to the bottom line. After all, no additional expenses would be extracted from the incremental price gain other than sales commissions. This is what makes strategic pricing so powerful.

However, in reality not all of the price gain hits the bottom line. Consider the cost factor. Costs rise and take a bite out of profit margins and need to be factored into margin calculations. And, it is possible to see a rise in dollar profit margins and at the same time see a drop in percentage gross margins or operating profit.

Don’t assume that you have an increase in margin percent when margin dollars improve. Use strategic pricing analytics to go through the calculations and understand the dynamics of price, volume, cost and margins on a dollar and percentage basis. You may be surprised at what you find.

In nearly every business there are performance goals of many varieties. Consider sales goals, cost reductions goals, margin goals, production goals, quality improvement goals and the list goes on. Rarely do we see a company with pricing goals. That is, using pricing as a strategic initiative to improve revenues and profit margins.

For many manufacturing and wholesale distribution firms there is a low level of awareness of strategic pricing and related goals. Strategic pricing uses data to determine price points on a transaction by transaction basis. (This is the very short definition of strategic pricing.) Think of using your historical pricing data as a reference point to help determine future prices. Using this data helps to create a pathway forward in price setting and ultimately price improvement that drives revenue and margins.

While many manufacturers and wholesale distributors may not be applying strategic pricing there are still opportunities for setting pricing goals. Pricing goals can be derived from actual increases in prices, reduced discounting, or stopping price leaks. Price leaks include freight allowances, excessive discounts, waived small order fees and the like.

Addressing just one of these areas and setting measureable price improvement goals is just one way to draw a focus toward strategic pricing and get your team to start thinking about pricing from a strategic standpoint. Then, of course, the key is to measure actual performance versus the set goals.

Do you know how pricing decisions are impacting your profit margins? If you are like most wholesale distributors and manufacturers you probably don’t. Measuring profit margins only goes so far but stops well short of actually measuring price performance. The objective is to isolate price and measure how prices have changed over a time period and contributed or detracted from profit margins.

Being able to focus just on price begins to create a culture in strategic pricing management. After all, what gets measured gets managed. So, being able to isolate and measure price performance gets management to think about how to positively affect prices. Reduced discounting, improve product mix, higher margin products, customers with low price sensitivity and a host of other targets will surface even with minimal analysis and discussion.

And, effective price measurement will identify the weak spots where better pricing decisions are not being supported. Think of sales reps that are consistently underpricing or discounting. Or, high value/low volume products that are underpriced. These areas may be ripe for price improvement will little risk.

Measuring price performance and giving pricing more visibility in the organization is a great first step towards managing pricing strategically. You might be surprised at what you find.

In most of the clients that our strategic pricing consultants engage with we sometimes see a company who is underpricing their business across the board. That is, in nearly every case the price is less than the threshold that the customer is willing to pay. One indicator is when your sales close rates are extremely high. You are essentially winning every deal and in some cases, your buyers even tell you that your pricing is very good.

While this certainly helps to achieve sales goals you are leaving valuable profit margins on the table. Furthermore, you may be contributing to margin degradation in your industry as competitors feel the need to match prices. So, how do you really know if you are underpricing across the board?

One approach is to conduct market research among your customer base to compare your customers’ perception of value on your offering versus your competitors offering. Having buyers rate and compare your delivered benefits to your competitors provides an apples-to-apples comparison on overall value. And, you will want them to score performance on pricing as well. When we then compare the performance of benefits versus price we have a ratio to measure how our value is perceived in the eyes of the buyer.

If your company’s perceived value rating is high it suggests there is room for price improvement. While this approach may not provide a granular view to price improvement targets it generally is adequate to identify across the board pricing issues. If you suspect that you are underpriced this approach can help to verify those suspicions and give the confidence to make adjustments.

Managers have an enormous number of measurements at their disposal to help them keep their finger on the pulse of business performance. Think of all the financial ratios and reports that are applied to nearly every aspect of a business operation. There are reports that measure sales, gross margin, operating profit, receivables, payables, quality, production efficiency and more.

But one critical report ­– the price performance report – is often missing. Yet pricing has more potential impact on profitability than any other profit driver. According to research by McKinsey & Company, a 1% improvement in price boosts net income by 11% for the average U.S. corporation. That means an additional $1 million to the bottom line for every $100 million in revenue.

So why are so few firms measuring their price performance? Wouldn’t it help to know whether your pricing is contributing positively or negatively to your profit margins? For many wholesale distributors and manufacturers, pricing can be dynamic, with prices varying for an item on a transaction-by-transaction basis. How do you know if your collective prices are increasing, holding or declining? And how are changes in pricing impacting your profit margins?

Price performance at the highest level is the change in overall price levels across a business. It measures the change in price on a percentage basis. For example, a business with a price performance improvement of 1.5% has seen prices increase overall by this amount and has contributed positively to profit margins. On the other side, a business with price performance of -1.25% has seen prices decline by this amount and has detracted from profit margins.

Measuring price performance is relatively easy, although it takes transactional-level data to execute. Measurement is simply defining the change in price across a time period multiplied by the number of units sold:

Price Performance = (Current Price – Previous Price) x Units Sold

The solution to this equation is the overall change in price-driven revenue. This equation is applied to each item sold in a given time period and summed to arrive at the total business impact.

Take the $100 million company that experiences a -1.5% price performance over a one-year period. Price was responsible for detracting from margin performance by $1.5 million. Margins may still have grown through cost reductions or increased sales, but price did not contribute to the gain.

The old saying “What gets measured gets managed” applies here. If you knew how your pricing was contributing to your financial performance, how would that change the way you manage your prices?

With insight into price performance, you begin to see where you are performing well and where there is room for improvement. What if you knew which items, markets, customers or sales reps were contributing positively to price performance and which ones were detracting from it? With measurements that provide visibility, you can manage more effectively and drive more margin to the bottom line.

For most wholesale distributors and manufacturers it is common to offer pricing discounts based on the quantity of an item purchased. For example, a single widget might sell for $10 but an order of 20 widgets might be priced at $9 each.

Our pricing consultants see many companies that have set clear structures in place by which to guide discount offerings. Purchases of 1-9 units might be priced at $10 while purchases of 10-19 units would be priced at $9. The problem our pricig experts see lies in the enforcement of such pricing discount schedules.

Take for example the company with $15 million in revenue who is leaking $700,000 in price and margin just because they are not adhering to their discount schedule. Exceptions become the rule and an analysis reveals that most customers are getting a deeper break on the discounts. So, the purchase described above of 1-9 units should be in effect paying list price at $10 but instead is only paying $9.

Containing quantity discount break point management can drive a significant amount of margin. Often, there is no need for adjusting the break points but simply adhering to the schedule that is already in place.

Does it ever make sense to price at a loss? Over the last 20 years in business we have seen nearly every company sell at least some items at a negative margin. Manufacturing companies and wholesale distributors typically have thousands of items and at least hundreds of customers. Sure, with this level of price complexity some transactions are bound to slip through at a loss. Costs may vary and prices may be adjusted on a customer by customer basis that leads to items sold at a negative margin. In many cases, a manufacturer or wholesale distributor may not even know they are selling at a loss or realize the extent of margin loss sales.

Other companies are fully aware of their negative margin business and choose to continue the practice for a variety of reasons. Here are just a few.

The manufacturing company that uses negative margin business to support overhead and maintain a level of productivity or capacity.

The wholesale distributor that must infrequently purchase incidental volume items in order to serve existing accounts. The distributor is unable to buy at a lower price and is squeezed by the market price thus resulting in a margin squeeze.

Where profit margin is measured on an account basis. Some items are intentionally priced at a loss to serve the broader needs of the customer but the overall profit margin of a specific account is positive.

As a competitive weapon. This one is particularly dangerous as it could trigger a price war.

Just to get business at a new account. We’ll increase prices later on additional items sold.

Costs are temporarily high on an individual item as production machinery may require updating.

These are just a few of the reasons we have seen in industry. Some may have an argument while others fall well short. So, what can happen when we sell at a loss besides the hit to profitability?

Competitors may react with their own price pressure often times causing industry participants to follow into a margin death spiral. This doesn’t always happen but the potential is real.

Buyers come to expect the low prices and it becomes very difficult to move them away from that expectation especially when it means increasing price double digits to get into the black.

Depending on the sales team compensation scheme, reps may continue to get paid commissions on negative margin sales while the company takes a hit on both the margin loss and commission payments…a double whammy for the firm. And, it becomes difficult to get the reps motivated to increase the price.

As price is used to help close the sale, reps are less likely to take the extra time to sell value and realize higher margins or know when to walk away from the sale. Again, depending on compensation plans, we find this particularly difficult for some sales reps to embrace as they will be paid regardless of the outcome.

As our pricing consultants are “pricing purists” and focused on helping our clients lift margin, we most often will argue against negative margin business. Taking the time to find acceptable margin business is time well spent. Yes, it takes longer to sell your value and it takes a little longer to find profitable business but the result in the end is significant.

Many companies struggle on the issue of negative margin transactions. What are your thoughts on this topic? I would like to hear from you and your perspectives. You may email me at rzuponcic@pricepointpartners.com.

Our price consultants find that most wholesale distributors and many manufacturers rely upon their customer facing teams to control or at least influence prices. In the most extreme cases, sales reps have complete decision making power to set prices as they see fit. In more moderate situations sales teams influence price setting by discounting. The rationale behind these scenarios is that the sales rep has street-level knowledge of the market and is in the best position to judge customer price sensitivity.

While front line teams have an important view of customers they often lack the information and data to make optimized price decisions. Here are three reasons why.

· For nearly all distributors and most manufacturers the pricing environment is complex. With thousands of SKUs, hundreds of customers and even a handful of markets, how can any single individual know the best price for every customer situation? Different SKUs in different markets to different customers can create millions of price permutations. Spreadsheets and prices lists are impossible to keep current much less provide optimized prices on the front lines.

· Sales team compensation plans are often mis-aligned with profit margin goals and price performance objectives. Most teams still have a heavy volume component to their incentives which is counter to achieving better pricing and improved margins.

· Customer facing teams generally lack adequate training in pricing execution. They don’t understand how even the smallest improvements in price can have tremendous impact to financial performance and incentives. Or, how to capture price premiums and when to best apply price discounts.

While the vast majority of sales teams are in a great position to generate margin improvement, they often are not provided the necessary information, tools and techniques.

Pricing complexity is addressed with technology. Using historical pricing data and analysis, strategic pricing software pinpoints the optimized price for every sales situation. It takes into account the myriad of attributes inherent in every sale situation and delivers pricing guidance to the sales rep that optimizes revenue and margin. Equipping the rep with science based pricing guidance means less time spent on pricing calculations and more time spent selling.

Sales incentive plans should be equally focused on rewarding price performance and volume achievement. For example, set a discount budget and reward reps when the budget is not fully utilized.

Finally, most customer facing teams have not been trained in the successful execution of pricing initiatives. From periodic price increases to discount programs sales reps are largely unaware of the impact these initiatives will have on the company’s financial performance and their own incentives. Our price consultants see sales teams achieve profit improvement of 1-2 margin points after participating in pricing training programs. That’s $100,000 to $200,000 on $10 million in revenue.

Powering your sales team with the knowledge, incentive and pricing guidance to execute at the point of sale is a sure fire way to increase revenues and lift margins. Sales teams are in a tremendous position to make an impact. Help them achieve success by providing them with the tools and knowledge that will give them pricing power.